Dividends Received Deduction Holding Period Reduced for Periods Where Risk of Loss Diminished

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8590]

RIN 1545-AR10

Dividends Received Deduction Holding Period Reduced for Periods

Where Risk of Loss Diminished

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the

reduction in the holding period of stock where a taxpayer has

diminished its risk of loss by holding one or more other positions with

respect to substantially similar or [[Page 14637]] related property. In

addition, this document contains final regulations relating to tax

straddles involving stock and substantially similar or related

property. The regulations, in response to specific congressional

direction, provide guidance to taxpayers with respect to the

availability of the dividends received deduction and the application of

the rules relating to tax straddles.

DATES: These regulations are effective March 20, 1995.

For dates of applicability of these regulations, see Sec. 1.246-

5(e) and Sec. 1.1092(d)-2(b).

FOR FURTHER INFORMATION CONTACT: Nicholas G. Bogos or Thomas M. Preston

of the Office of the Assistant Chief Counsel, Financial Institutions

and Products, (202) 622-3920 or 622-3940, respectively (not a toll-free

call).

SUPPLEMENTARY INFORMATION:

Background

On May 27, 1993, proposed regulations Sec. 1.246-5 and

Sec. 1.1092(d)-2 under sections 246(c)(4)(C) and 1092(d)(3)(B)

respectively were published in the Federal Register (58 FR 45080). A

public hearing was held on September 28, 1993. After IRS and Treasury

consideration of the public comments on the proposed regulations, the

regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

The final regulations retain, with only minor modifications, the

definitions of substantially similar or related property and diminished

risk of loss that are contained in the proposed regulations. Property

is substantially similar or related to stock if the property and the

stock primarily reflect the performance of a single firm or enterprise,

the same industry or industries, or the same economic factor or factors

(such as interest rates, commodity prices, or foreign-currency exchange

rates), and changes in the fair market value of the stock are

reasonably expected to approximate, directly or inversely, changes in

the fair market value of the property. A taxpayer has diminished its

risk of loss if changes in the fair market values of the stock and a

position with respect to substantially similar or related property are

reasonably expected to vary inversely.

Several commentators argued that the definition of substantially

similar or related property improperly focuses on the economic

relationship between the stock and the other property held by the

taxpayer. They argued that this approach fails to give independent

substance to the two parts of the statutory test, namely, (a) risk

reduction, and (b) holding positions in substantially similar or

related property.

The IRS and Treasury believe that the rule, as finalized, gives

appropriate weight both to risk reduction and to whether the taxpayer

holds a position in substantially similar or related property. The only

way to determine when properties are substantially similar or related

for purposes of section 246(c)(4)(C) is by taking into account the

economic characteristics of the properties. A definition that did not

look to the economic relationships of properties would give undue

deference to labels and would not serve the purposes of section

246(c)(4)(C).

Several commentators suggested that the regulations should provide

a safe harbor under which taxpayers could establish that properties are

not substantially similar or related by demonstrating a sufficiently

low mathematical correlation between the changes in the price of stock

and changes in the price of the other property. The final regulations

do not include the suggested safe harbor because the IRS and Treasury

have not identified a simple, workable safe harbor that would be

appropriate in all cases and that the IRS could effectively administer.

The IRS and Treasury continue to welcome suggestions for a safe harbor.

Although the final regulations retain the definition of

substantially similar or related property, Example 6 of the proposed

regulations has been eliminated. This example, which was widely

criticized by commentators, concludes that a nonparticipating, fixed-

term, preferred stock is substantially similar to Treasury securities

because both types of property primarily reflect the performance of the

same economic factor--interest rates--and changes in the value of the

stock will approximate changes in the value of the Treasury securities.

The commentators argued that, although hedging preferred stock with

Treasury securities may provide protection against the impact of

substantial movements in overall interest rates, the value of preferred

stock can also be significantly affected by other economic factors,

such as the issuer's credit risk. Thus, they argued, the stock and the

Treasury securities do not primarily reflect the performance of the

same economic factor, and changes in their fair market values are not

reasonably expected to approximate each other.

Whether offsetting positions constitute substantially similar or

related property is determined based on the facts and circumstances of

each case. Commentators demonstrated that, in many cases, changes in

the price of Treasury securities would not approximate changes in the

price of a preferred stock. Therefore, Example 6 of the proposed

regulations has been eliminated. Whether Treasury securities or other

interest-sensitive property is substantially similar or related to a

particular preferred stock must be decided on a case-by-case basis. The

elimination of Example 6 does not preclude a finding that such property

or securities are substantially similar or related to preferred stock

in appropriate cases.

Examples 3 and 8 of the proposed regulations were eliminated

because, after further consideration, the IRS and Treasury decided the

regulations were sufficiently clear without the examples.

The proposed regulations state that, notwithstanding the general

rule, two portfolios of stocks are substantially similar or related if

changes in their fair market values are reasonably expected to

approximate each other. Commentators suggested that this rule did not

give effect to the statement in the legislative history that the

substantially similar or related standard is not satisfied merely

because the taxpayer is an investor with diversified holdings and

acquires a regulated futures contract or an option on a stock index to

hedge general market risks. Commentators suggested that, even if

changes in the values of two portfolios approximate each other, the

substantially similar or related standard should be met only if the

portfolios substantially overlap.

The final regulations adopt this suggestion subject to an anti-

abuse rule. Under the final regulations, a position that reflects the

value of a portfolio is not treated as substantially similar or related

to the taxpayer's stock holdings unless the stock holdings and the

portfolio substantially overlap. For this purpose, a taxpayer's stock

holdings substantially overlap with a portfolio if the taxpayer holds

70 percent, by value, of the stocks in the portfolio (that is, the

taxpayer holds 70 percent of the capitalization of the portfolio). A

mechanical rule is provided for determining substantial overlap. The

final regulations also define a portfolio as 20 or more stocks and

provide that positions that reflect the value of more than one stock

but less than 20 are treated as positions in each of the underlying

stocks.

If the anti-abuse rule applies, a position that reflects the value

of two or more stocks (including a portfolio) is treated as

substantially similar or related property even if those stocks and

[[Page 14638]] the taxpayer's stock holdings do not substantially

overlap. The anti-abuse rule applies when the following two conditions

are met. First, changes in the value of the position or the stocks

reflected in a position are reasonably expected to virtually track

(directly or inversely) changes in the value of the taxpayer's stock

holdings or any portion of the taxpayer's stock holdings and other

positions of the taxpayer; and, second, the position is acquired or

held as part of a plan a principal purpose of which is to obtain tax

savings (including by deferring tax) that are significantly in excess

of the expected pre-tax economic profits from the plan. Of course,

common law doctrines and statutory authorities, such as substance over

form, the sham transaction doctrine, and the clear reflection of income

requirement, continue to apply notwithstanding any provision of these

regulations. See, e.g., Sheldon v. Commissioner, 94 T.C. 738 (1990).

The final regulations generally retain the other provisions of the

proposed regulations with the following modifications. The final

regulations define a position, for purposes of section 246(c)(4)(C), as

an interest (including a futures or forward contract or an option) in

property or any contractual right to a payment, whether or not

severable from stock or other property. Thus, for purposes of section

246(c)(4)(C), stock coupled with an option to sell the stock will not

be treated as a single instrument (regardless of whether the option

trades separately from the stock). A position does not, however,

include traditional equity rights to demand payment from the issuer,

such as rights traditionally provided by mandatorily redeemable

preferred stock. The definition of position does not apply for purposes

of section 1092, which includes its own definition of position in

section 1092(d)(2).

The final regulations make clear that certain convertible

instruments are substantially similar or related property. Thus, the

holding period of stock may be tolled if the taxpayer holds an

instrument that is convertible into property that is substantially

similar or related to the taxpayer's stock. The situations identified

in the final regulations are taken directly from the legislative

history underlying the statutory provision. See H.R. Conf. Rep. No.

861, 98th Cong., 2d Sess. 818 (1984).

For hedges of positions other than stock, the final regulations

retain the rule in the proposed regulations that hedges of one position

are not treated as hedges of another position (including stock). The

final regulations clarify that relationships established in the

taxpayer's books and records at the time the positions are entered into

are given substantial deference. In addition, the final regulations

provide that a taxpayer that diminishes its risk of loss in stock by

holding a position in substantially similar or related property is

treated as diminishing the risk of loss on the shares with the shortest

holding period.

The final regulations retain the rule in the proposed regulations

that a guarantee, surety agreement, or similar arrangement is treated

as substantially similar or related property if it substantially

offsets decreases in the fair market value of the stock. The IRS and

Treasury caution that these arrangements or similar rights (even if

they do not substantially offset decreases in the fair market value of

the stock) may also be treated as options (whether settled in cash or

property) to sell the stock for purposes of section 246(c)(4)(A). For

example, if an instrument is debt for state law purposes but stock for

federal income tax purposes, creditor's rights on the instrument are

treated as options to sell. See Rev. Rul. 94-28, 1994-1 C.B. 86.

The final regulations clarify the treatment of notional principal

contracts as substantially similar or related property. Under the final

regulations, an analysis of whether a notional principal contract is a

position in substantially similar or related property that diminishes

risk must take into account the gross payments due under the contract

even if payments under the contract are netted for other purposes.

Thus, a taxpayer cannot look solely to the net payments that it expects

to receive and argue that, because fluctuations in the value of the

swap may not approximate changes in the value of the stock, the swap is

not substantially similar or related to the stock, and does not

diminish the taxpayer's risk of loss.

The final regulations defining substantially similar or related

property under section 1092 of the Code are found in new

Sec. 1.1092(d)-2. The regulations provide that the definition of the

term substantially similar or related property in Sec. 1.246-5 is

generally applicable for purposes of section 1092(d)(3)(B).

Effective Dates

The regulations contained in this Treasury decision generally are

effective with respect to dividends received, and to positions

established, on or after March 17, 1995 with respect to stock acquired

after July 18, 1984. However, the regulations apply to dividends

received by a taxpayer on stock acquired after July 18, 1984, and to

positions established after March 1, 1984, with respect to certain

specific transactions listed in the legislative history.

Special Analysis

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations, and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on their

impact on small business.

Drafting Information

The principal authors of these regulations are Nicholas G. Bogos

and Thomas M. Preston, both of the Office of Assistant Chief Counsel

(Financial Institutions and Products). However, other personnel from

the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended to read as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *.

Section 1.246-5 also issued under 26 U.S.C. 246(c) and 7701(f).

* * *

Section 1.1092(d)-2 also issued under 26 U.S.C. 1092(d)(3)(B). *

* *

Par. 2. Section 1.246-5 is added to read as follows:

Sec. 1.246-5 Reduction of holding periods in certain situations.

(a) In general. Under section 246(c)(4)(C), the holding period of

stock for purposes of the dividends received deduction is appropriately

reduced for any period in which a taxpayer has diminished its risk of

loss by holding one or more other positions with respect to

substantially similar or related property. This section provides rules

for applying section 246(c)(4)(C). [[Page 14639]]

(b) Definitions--(1) Substantially similar or related property. The

term substantially similar or related property is applied according to

the facts and circumstances in each case. In general, property is

substantially similar or related to stock when--

(i) The fair market values of the stock and the property primarily

reflect the performance of--

(A) A single firm or enterprise;

(B) The same industry or industries; or

(C) The same economic factor or factors such as (but not limited

to) interest rates, commodity prices, or foreign-currency exchange

rates; and

(ii) Changes in the fair market value of the stock are reasonably

expected to approximate, directly or inversely, changes in the fair

market value of the property, a fraction of the fair market value of

the property, or a multiple of the fair market value of the property.

(2) Diminished risk of loss. A taxpayer has diminished its risk of

loss on its stock by holding positions with respect to substantially

similar or related property if changes in the fair market values of the

stock and the positions are reasonably expected to vary inversely.

(3) Position. For purposes of this section, a position with respect

to property is an interest (including a futures or forward contract or

an option) in property or any contractual right to a payment, whether

or not severable from stock or other property. A position does not

include traditional equity rights to demand payment from the issuer,

such as the rights traditionally provided by mandatorily redeemable

preferred stock.

(4) Reasonable expectations. For purposes of paragraphs (b)(1)(i),

(b)(2), or (c)(1)(vi) of this section, reasonable expectations are the

expectations of a reasonable person, based on all the facts and

circumstances at the later of the time the stock is acquired or the

positions are entered into. Reasonable expectations include all

explicit or implicit representations made with respect to the marketing

or sale of the position.

(c) Special rules--(1) Positions in more than one stock--(i) In

general. This paragraph (c)(1) provides rules for the treatment of

positions that reflect the value of more than one stock. In general,

positions that reflect the value of a portfolio of stocks are treated

under the rules of paragraphs (c)(1) (ii) through (iv) of this section,

and positions that reflect the value of more than one stock but less

than a portfolio are treated under the rules of paragraph (c)(1)(v) of

this section. A portfolio for this purpose is any group of stocks of 20

or more unrelated issuers. Paragraph (c)(1)(vi) of this section

provides an anti-abuse rule.

(ii) Portfolios. Notwithstanding paragraph (b)(1) of this section,

a position reflecting the value of a portfolio of stocks is

substantially similar or related to the stocks held by the taxpayer

only if the position and the taxpayer's holdings substantially overlap

as of the most recent testing date. A position may be substantially

similar or related to a taxpayer's entire stock holdings or a portion

of a taxpayer's stock holdings.

(iii) Determining substantial overlap. This paragraph (c)(1)(iii)

provides rules for determining whether a position and a taxpayer's

stock holdings or a portion of a taxpayer's stock holdings

substantially overlap. Paragraphs (c)(1)(iii) (A) through (C) of this

section determine whether there is substantial overlap as of any

testing date.

(A) Step One. Construct a subportfolio (the Subportfolio) that

consists of stock in an amount equal to the lesser of the fair market

value of each stock represented in the position and the fair market

value of the stock in the taxpayer's stock holdings. (The Subportfolio

may contain fewer than 20 stocks.)

(B) Step Two. If the fair market value of the Subportfolio is equal

to or greater than 70 percent of the fair market value of the stocks

represented in the position, the position and the Subportfolio

substantially overlap.

(C) Step Three. If the position does not substantially overlap with

the Subportfolio, repeat Steps One and Two (paragraphs (c)(1)(iii)(A)

and (B) of this section) reducing the size of the position. The largest

percentage of the position that results in a substantial overlap is

substantially similar or related to the Subportfolio determined with

respect to that percentage of the position.

(iv) Testing date. A testing date is any day on which the taxpayer

purchases or sells any stock if the fair market value of the stock or

the fair market value of substantially similar or related property is

reflected in the position, any day on which the taxpayer changes the

position, or any day on which the composition of the position changes.

(v) Nonportfolio positions. A position that reflects the fair

market value of more than one stock but not of a portfolio of stocks is

treated as a separate position with respect to each of the stocks the

value of which the position reflects.

(vi) Anti-abuse rule. Notwithstanding paragraphs (c)(1)(i) through

(v) of this section, a position that reflects the value of more than

one stock is a position in substantially similar or related property to

the appropriate portion of the taxpayer's stock holdings if--

(A) Changes in the value of the position or the stocks reflected in

the position are reasonably expected to virtually track (directly or

inversely) changes in the value of the taxpayer's stock holdings, or

any portion of the taxpayer's stock holdings and other positions of the

taxpayer; and

(B) The position is acquired or held as part of a plan a principal

purpose of which is to obtain tax savings (including by deferring tax)

the value of which is significantly in excess of the expected pre-tax

economic profits from the plan.

(2) Options--(i) Options that are significantly out of the money.

For purposes of paragraph (b)(2) of this section, an option to sell

that is significantly out of the money does not diminish the taxpayer's

risk of loss on its stock unless the option is held as part of a

strategy to substantially offset changes in the fair market value of

the stock.

(ii) Conversion rights. Notwithstanding paragraphs (b)(1) and (2)

of this section, a taxpayer is treated as diminishing its risk of loss

by holding substantially similar or related property if it engages in

the following transactions or their substantial equivalents--

(A) A short sale of common stock while holding convertible

preferred stock of the same issuer and the price changes of the

convertible preferred stock and the common stock are related;

(B) A short sale of a convertible debenture while holding

convertible preferred stock into which the debenture is convertible or

common stock; or

(C) A short sale of convertible preferred stock while holding

common stock.

(3) Stacking rule. If a taxpayer diminishes its risk of loss by

holding a position in substantially similar or related property with

respect to only a portion of the shares that the taxpayer holds in a

particular stock, the holding period of those shares having the

shortest holding period is reduced.

(4) Guarantees, surety agreements, or similar arrangements. A

taxpayer has diminished its risk of loss on stock by holding a position

in substantially similar or related property if the taxpayer is the

beneficiary of a guarantee, surety agreement, or similar arrangement

and the guarantee, surety agreement, or similar arrangement provides

for payments that will substantially offset decreases in the fair

market value of the stock. [[Page 14640]]

(5) Hedges counted only once. A position established as a hedge of

one outstanding position, transaction, or obligation of the taxpayer

(other than stock) is not treated as diminishing the risk of loss with

respect to any other position held by the taxpayer. In determining

whether a position is established to hedge an outstanding position,

transaction, or obligation of the taxpayer, substantial deference will

be given to the relationships that are established in its books and

records at the time the position is entered into.

(6) Use of related persons or pass-through entities. Positions held

by a party related to the taxpayer within the meaning of sections

267(b) or 707(b)(1) are treated as positions held by the taxpayer if

the positions are held with a view to avoiding the application of this

section or Sec. 1.1092(d)-2. In addition, a taxpayer is treated as

diminishing its risk of loss by holding substantially similar or

related property if the taxpayer holds an interest in, or is the

beneficiary of, a pass-through entity, intermediary, or other

arrangement with a view to avoiding the application of this section or

Sec. 1.1092(d)-2.

(7) Notional principal contracts. For purposes of this section,

rights and obligations under notional principal contracts are

considered separately even though payments with regard to those rights

and obligations are generally netted for other purposes. Therefore, if

a taxpayer is treated under the preceding sentence as receiving

payments under a notional principal contract when the fair market value

of the taxpayer's stock declines, the taxpayer has diminished its risk

of loss by holding a position in substantially similar or related

property regardless of the netting of the payments under the contract

for any other purposes.

(d) Examples. The following examples illustrate the provisions of

this section:

Example 1. General application to common stock. Corporation A and

Corporation B are both automobile manufacturers. The fair market values

of Corporation A and Corporation B common stock primarily reflect the

value of the same industry. Because Corporation A and Corporation B

common stock are affected not only by the general level of growth in

the industry but also by individual corporate management decisions and

corporate capital structures, changes in the fair market value of

Corporation A common stock are not reasonably expected to approximate

changes in the fair market value of the Corporation B common stock.

Under paragraph (b)(1) of this section, Corporation A common stock is

not substantially similar or related to Corporation B common stock.

Example 2. Common stock value primarily reflects commodity price.

Corporation C and Corporation D both hold gold as their primary asset,

and historically changes in the fair market value of Corporation C

common stock approximated changes in the fair market value of

Corporation D common stock. Corporation M purchased Corporation C

common stock and sold short Corporation D common stock. Corporation C

common stock is substantially similar or related to Corporation D

common stock because their fair market values primarily reflect the

performance of the same economic factor, the price of gold, and changes

in the fair market value of Corporation C common stock are reasonably

expected to approximate changes in the fair market value of Corporation

D common stock. It was reasonably expected that changes in the fair

market values of the Corporation C common stock and the short position

in Corporation D common stock would vary inversely. Thus, Corporation M

has diminished its risk of loss on its Corporation C common stock for

purposes of section 246(c)(4)(C) and this section by holding a position

in substantially similar or related property.

Example 3. Portfolios of stocks--(i) Corporation Z holds a

portfolio of stocks and acquires a short position on a publicly traded

index through a regulated futures contract (RFC) that reflects the

value of a portfolio of stocks as defined in paragraph (c)(1)(i) of

this section. The index reflects the fair market value of stocks A

through T. The values of stocks reflected in the index and the values

of the same stocks in Corporation Z's holdings are as follows:

------------------------------------------------------------------------

Z's

Stock holdings RFC Subportfolio

------------------------------------------------------------------------

A...................................... $300 $300 $300

B...................................... 300 300 300

C...................................... -- 300 --

D...................................... 400 500 400

E...................................... 300 500 300

F...................................... 300 500 300

G...................................... 500 600 500

H...................................... 300 300 300

I...................................... -- 300 --

J...................................... 400 450 400

K...................................... 200 500 200

L...................................... 200 400 200

M...................................... 200 500 200

N...................................... 100 200 100

O...................................... -- 200 --

P...................................... 200 200 200

Q...................................... 100 300 100

R...................................... 200 100 100

S...................................... 100 100 100

T...................................... 100 200 100

--------------------------------

Totals........................... $4,200 $6,750 $4,100

------------------------------------------------------------------------

(ii) The position is substantially similar or related to Z's stock

holdings only if they substantially overlap. To determine whether they

substantially overlap, Corporation Z must construct a Subportfolio of

stocks with the lesser of the value of the stock as reflected in the

RFC and its holdings. The Subportfolio is given in the rightmost column

above. The value of the Subportfolio is 60.74 percent of the value of

the stocks represented in the position ($4100$6750), so the

position and the Subportfolio do not substantially overlap.

(iii) To determine whether any portion of the position

substantially overlaps with any portion of the Z's stock holdings, the

values of the stocks in the RFC are reduced for purposes of the above

steps. Eighty percent of the position and the corresponding

subportfolio (consisting of stocks with a value of the lesser of the

stocks represented in Z's holdings and in 80 percent of the RFC)

substantially overlap, computed as follows:

------------------------------------------------------------------------

Z's 80% of

Stock holdings RFC Subportfolio

------------------------------------------------------------------------

A...................................... $300 $240 $240

B...................................... 300 240 240

C...................................... -- 240 --

D...................................... 400 400 400

E...................................... 300 400 300

F...................................... 300 400 300

G...................................... 500 480 480

H...................................... 300 240 240

I...................................... -- 240 --

J...................................... 400 360 360

K...................................... 200 400 200

L...................................... 200 320 200

M...................................... 200 400 200

N...................................... 100 160 100

O...................................... -- 160 --

P...................................... 200 160 160

Q...................................... 100 240 100

R...................................... 200 80 80

S...................................... 100 80 80

T...................................... 100 160 100

--------------------------------

Totals........................... $4,200 $5,400 $3,780

------------------------------------------------------------------------

(iv) Because $3,780 is 70 percent of $5,400, the Subportfolio

substantially overlaps with 80 percent of the position. Under paragraph

(c)(3) of this section, Z's stocks having the shortest holding period

are treated as included in the Subportfolio. A larger portion of Z's

stocks may be treated as substantially similar or related property

under the [[Page 14641]] anti-abuse rule of paragraph (c)(1)(vi) of

this section.

Example 4. Hedges counted only once. January 1, 1996, Corporation X

owns a $100 million portfolio of stocks all of which would

substantially overlap with a $100 million regulated futures contract

(RFC) on a commonly used index (the Index). On January 15, Corporation

X enters into a $100 million short position in an RFC on the Index with

a March delivery date and enters into a $75 million long position in an

RFC on the Index for June delivery. Also on January 15, 1996,

Corporation X indicates in its books and records that the long and

short RFC positions are intended to offset one another. Under paragraph

(c)(5) of this section, $75 million of the short position in the RFC is

not treated as diminishing the risk of loss on the stock portfolio and

instead is treated as a straddle or a hedging transaction, as

appropriate, with respect to the $75 million long position in the RFC,

under section 1092. The remaining $25 million short position is treated

as diminishing the risk of loss on the portfolio by holding a position

in substantially similar or related property. The rules of paragraph

(c)(1) determine how much of the portfolio is subject to this rule and

the rules of paragraph (c)(3) determine which shares have their holding

periods tolled.

(e) Effective date--(1) In general. The provisions of this section

apply to dividends received on or after March 17, 1995, on stock

acquired after July 18, 1984.

(2) Special rule for dividends received on certain stock.

Notwithstanding paragraph (e)(1) of this section, this section applies

to any dividends received by a taxpayer on stock acquired after July

18, 1984, if the taxpayer has diminished its risk of loss by holding

substantially similar or related property involving the following types

of transactions--

(i) The short sale of common stock when holding convertible

preferred stock of the same issuer and the price changes of the two

stocks are related, or the short sale of a convertible debenture while

holding convertible preferred stock into which the debenture is

convertible (or common stock), or a short sale of convertible preferred

stock while holding common stock; or

(ii) The acquisition of a short position in a regulated futures

contract on a stock index, or the acquisition of an option to sell the

regulated futures contract or the stock index itself, or the grant of a

deep-in-the-money option to buy the regulated futures contract or the

stock index while holding the stock of an investment company whose

principal holdings mimic the performance of the stocks included in the

stock index; or alternatively, while holding a portfolio composed of

stocks that mimic the performance of the stocks included in the stock

index.

Par. 3. Section 1.1092(d)-2 is added to read as follows:

Sec. 1.1092(d)-2 Personal property.

(a) Special rules for stock. Under section 1092(d)(3)(B), personal

property includes any stock that is part of a straddle, at least one of

the offsetting positions of which is a position with respect to

substantially similar or related property (other than stock). For

purposes of this rule, the term substantially similar or related

property is defined in Sec. 1.246-5 (other than Sec. 1.246-5(b)(3)).

The rule in Sec. 1.246-5(c)(6) does not narrow the related party rule

in section 1092(d)(4).

(b) Effective date--(1) In general. This section applies to

positions established on or after March 17, 1995.

(2) Special rule for certain straddles. This section applies to

positions established after March 1, 1984, if the taxpayer

substantially diminished its risk of loss by holding substantially

similar or related property involving the following types of

transactions--

(i) Holding offsetting positions consisting of stock and a

convertible debenture of the same corporation where the price movements

of the two positions are related; or

(ii) Holding a short position in a stock index regulated futures

contract (or alternatively an option on such a regulated futures

contract or an option on the stock index) and stock in an investment

company whose principal holdings mimic the performance of the stocks

included in the stock index (or alternatively a portfolio of stocks

whose performance mimics the performance of the stocks included in the

stock index).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Dated: March 3, 1995.

Approved: Leslie Samuels, Assistant Secretary of the Treasury

(Tax Policy).

[FR Doc. 95-6693 Filed 3-17-95; 8:45 am]

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